RESERVE BANK OF AUSTRALIA
RECENT DEVELOPMENTS IN THE
GLOBAL AND AUSTRALIAN ECONOMIES
Philip Lowe
Assistant Governor (Economic)
Australian Industry Group 10th Annual Economic Forum
Sydney - 25 March 2010
RECENT DEVELOPMENTS IN THE GLOBAL AND
AUSTRALIAN ECONOMIES
Thank you for the invitation to speak this morning. I am very pleased to be able to
continue the long-standing relationship between the Reserve Bank of Australia and
the Australian Industry Group. Over the years, we have found this relationship very
valuable and I hope and trust that this will continue.
This morning, I would like to talk about some of the recent developments in both the
world and Australian economies and the implications of these developments for the
outlook for the Australian economy.
The World Economy
The world economy is gradually recovering from the worst downturn since World
War II. This recovery though is occurring on two different tracks (Graph 1). As a
group, the G7 countries are experiencing only relatively weak growth, especially
when viewed against the very large contraction in output that occurred. In contrast,
the picture in Asia is quite different, with many of the economies in the region having
had near V-shaped recoveries. There has also been a reasonably solid bounce back in
some other parts of the world with, for example, Brazil growing quite strongly over
the past year.
Graph 1
World GDP Growth
Per cent, weighted using GDP at PPP exchange rates
%
G7 economies
Asia excluding Japan
9
%
9
6
6
Year-ended
3
3
0
0
Quarterly
-3
-3
-6
2002
2006
2010
2002
2006
-6
2010
Sources: CEIC; RBA; Thomson Reuters
This two-speed world is evident not just in the GDP data but also in the
unemployment and inflation data.
Unemployment rates in both the United States and the euro area are around 10 per
cent and a sustained reduction still looks some time off (Graph 2). In contrast,
unemployment rates are now clearly falling in Asia and are much lower than in the
major advanced economies.
2.
Graph 2
Unemployment Rate
%
%
10
10
Euro area
8
8
US
6
6
4
4
Higher-income Asian economies
2
0
2
2000
2002
2004
2006
2008
2010
0
Sources: CEIC; Thomson Reuters
In terms of inflation, in both the United States and the euro area, core measures are
still trending down, and they are likely to continue doing so for some time yet
(Graph 3). Again, in contrast, core rates have clearly bottomed in Asia and now look
to be rising in a number of countries in the region.
Graph 3
Core Consumer Price Inflation
Six-month-ended annualised
%
%
US
3
3
2
2
1
1
Euro area
%
%
Other east Asia
(excluding Japan)
3
3
0
0
China
-3
-3
-6
-6
2003
2004
2005
2006
2007
2008
2009
2010
Sources: CEIC; RBA; Thomson Reuters
Rather than run through more of the recent economic data, I would like to touch on
three broad issues that are likely to play a major role in shaping how the world
economy evolves over the next few years. The first of these is the need for the
advanced economies to consolidate their public finances. The second is the
realignment of capital flows, given the likelihood of an extended period of low
interest rates in the advanced economies. And the third is the challenge of increasing
domestic demand in Asia.
3.
(i)
Public finances
Of these three issues, the one that has attracted the most attention recently is public
finances. This is partly the result of what has been going on in Greece but, more
broadly, it reflects the difficult fiscal positions in which many advanced economies
currently find themselves. In the United States, the federal budget deficit for 2009
was around 10 per cent of GDP. In Japan, the deficit was almost as large, and for the
euro area as a whole it was around 6 per cent, with some euro area countries having
much larger deficits than this average. Furthermore, these large deficits come after
three decades over which the ratio of public debt to GDP for the G7 economies as a
whole trended higher (Graph 4). They also come at a time when there will be
significant medium-term budget pressures due to the ageing of the population.
Graph 4
G7 – Net Public Debt
Per cent of GDP
%
%
80
80
40
40
0
1984
1989
1994
1999
2004
2009
0
2014
Source: IMF
Over coming years, many governments will need to take significant steps to improve
their public finances. The flexibility that they have to determine the timing and size
of these steps is limited by the fact that they went into the current downturn with
already high levels of debt. As a result of the poor starting points, many are now
treading a fairly narrow path. On the one hand, tightening fiscal policy in the very
near term risks derailing the recovery, while not doing so risks a damaging loss of
confidence.
How these risks are managed is likely to have a major effect on how the world
economy evolves over the next few years. Presumably, what is required is for the
affected countries to have credible medium-term fiscal consolidation strategies.
While this is easier to say than to do, ensuring the confidence of investors is an
important ingredient if the recovery is to be sustained.
4.
(ii) Capital flows
This brings me to the second, but related, issue – that of capital flows.
Most of the advanced economies are currently operating well below full capacity and,
given the subdued nature of the recovery, it is likely to be some time before this
excess capacity is wound back. One consequence is that, provided inflation
expectations remain well anchored, official interest rates in these economies – which
are currently at historically low levels – are likely to remain below average for a
considerable period of time (Graph 5). In contrast, elsewhere, including in Asia and
Australia where growth is stronger, interest rates are likely to be relatively higher.
This interest differential is likely to lead to a flow of capital from the major advanced
economies to Asia and other better-performing areas of the world.
Graph 5
G7 – Average Policy Rate
%
%
12
12
8
8
4
4
0
1960
1970
1980
1990
2000
0
2010
Sources: Federal Reserve Bank of New York; Global Financial Data; Thomson Reuters
In Asia, concerns are already emerging about the implications of this. In particular,
some countries are worried about the potential for volatile capital flows to be
destabilising for their economies. The concern is that capital inflows in the near term
will later turn into capital outflows when interest rates in the advanced economies do
eventually normalise, and that this could be disruptive. As a way of insuring
themselves against this risk, some central banks continue to accumulate foreign
reserves. A number of countries in the region are also concerned about the effects of
capital inflows on their domestic banking systems, with some having taken steps to
rein in bank lending growth, particularly in cases where property prices are increasing
strongly.
A related consideration is the effect of these capital flows on exchange rates in the
region. In general, there is considerably less tolerance for large movements in
exchange rates in many of these countries than there is in Australia. In our own case,
movements in the value of the Australian dollar are largely seen to be a stabilising
force for the economy. There is also a general acceptance of the view that, over the
next few years, our real exchange rate is likely to be higher than the average over the
5.
past decade or so. In contrast, in much of Asia, where international trade shares are
considerably higher than in Australia, movements in exchange rates tend to be
viewed with more concern, particularly when they are seen to be driven by
speculative capital flows.
One other related consideration is the impact on asset markets around the world of an
extended period of low official interest rates in the major advanced economies. When
the global economy was in this situation around five years ago things did not work
out well. While the current environment is very different from that in the middle of
the 2000s, this earlier experience suggests that we need to watch the financial side of
the global economy very carefully, particularly when interest rates are unusually low.
(iii) Domestic demand in Asia
The third issue I would like to touch on is the growth of domestic demand in Asia.
For some decades, many countries in Asia have had a growth strategy focused on
exports. Given the strong growth in consumption in the major western economies,
this strategy worked. However, many of the countries in Asia recognise that given the
subdued outlook for the advanced economies, there will now need to be a stronger
emphasis on growth in domestic demand than has been the case in the past.
China provides a good example here. Over the past two decades, the share of
household consumption in Chinese GDP has declined from just under 50 per cent to
35 per cent – a very low level by international standards. This decline reflects two
broad developments. The first is a reduction in the share of national income going to
households; in the early 1990s, this share stood at nearly 70 per cent, but by late
2008, it had fallen to less than 60 per cent (Graph 6). The second factor is an increase
in the household saving rate; in the early 1990s, around 30 per cent of household
income was saved, while today this share is close to 40 per cent.
Graph 6
China – Household Income and Saving
%
%
Disposable income
Saving ratio
Share of nominal GDP
Share of disposable income
70
40
65
35
60
30
55
1993
1998
Sources: CEIC; RBA
2003
2008
1998
2003
25
2008
6.
In China, as in many parts of Asia, there is now a recognition that policies to promote
consumption are likely to play a more important role than was previously the case. In
the past, strong consumption growth was often seen as something that would follow
strong exports, rather than be a driver of the economy itself. This view is gradually
changing and this is leading to an increased focus on structural reforms to increase
the share of national income going to the household sector and to reduce the
household saving rate. While reforms in these areas can be difficult, they are
important if Asia, as a whole, is to continue to grow strongly in the face of subdued
demand for exports from the region.
How things play out in each of these three areas – public-sector debt, capital flows
and structural policies in Asia – will have a significant impact on the global
environment in which the Australian economy finds itself over the year ahead. As the
Reserve Bank has spelt out a number of times recently, our central scenario is a
relatively positive one. The economies in Asia are expected to continue growing
reasonably solidly, while the advanced economies are expected to have only a
subdued recovery, weighed down by the need to consolidate balance sheets in both
the household and public sectors. Around this central scenario there are, however,
clearly risks, particularly associated with the three issues that I have just touched on.
Given these risks, one question is how should policy be set? The Reserve Bank’s
general approach has been to proceed on the basis of the central scenario, but be
prepared to respond if things turn out differently, as we did in late 2008 when the
global outlook took a marked turn for the worse. The alternative of waiting to see
how the myriad of risks evolves before adjusting policy runs the significant downside
of moving too late, particularly given that the economy is starting this upswing with
less spare capacity than in previous upswings. Fortunately, in Australia we have had
the policy flexibility to respond to changing events as they have occurred and this has
served us well.
The Australian Economy
I would now like to turn more specifically to the Australian economy, where the run
of data over the past few months has tended to be on the firm side. Employment
growth has been robust, business and consumer confidence is above average, the
housing market has been strong, and there are signs that the period of business
deleveraging is coming to an end (Graph 7). Collectively, these outcomes provide us
with some confidence that the economy is now in a reasonably solid upswing.
7.
Graph 7
Unemployment and Business Confidence
%
%
Unemployment rate
11
11
9
9
7
7
5
5
%
%
Business confidence*
15
15
0
0
-15
-15
-30
-30
-45
1990
1994
1998
2002
-45
2010
2006
* Net balance; deviation from long-run average
Sources: ABS; NAB; RBA
Over the course of this year, the nature of this upswing is, however, likely to change
somewhat. Recently, the overall level of spending in Australia has been supported by
strong growth in public-sector demand. This has occurred at a time when growth in
private-sector demand has been relatively weak (Graph 8). As we move into the
second half of 2010, this configuration is likely to change. Public-sector investment is
projected to decline, particularly as spending on the Federal Government’s school
building program tails off. But moving in the other direction, private-sector business
investment is expected to strengthen further, particularly in the resources sector.
Graph 8
Domestic Final Demand Growth*
Financial years
%
%
Private
6
6
4
4
Public
2
2
0
0
-2
97/98
00/01
03/04
06/07
09/10
-2
* Adjusted for transfers between the private and other sectors and the
privatisation of Telstra; 2009/10 based on financial year to date.
Sources: ABS; RBA
This expected rise in business investment is underpinned by the strong outlook for the
terms of trade. Recently, the spot prices of iron ore and coal have risen, and the prices
that exporters will receive over the next year look likely to be substantially higher
than those received over the past year (Graph 9). As a result, a significant rise in the
8.
terms of trade is expected over the year ahead. While movements in the terms of trade
do not get the same high-frequency attention as many of the monthly economic
indicators, history suggests that they have a large influence on how the overall
economy performs. Among other things, they can affect the investment climate, the
government’s budget position, asset values, overall confidence in the economy and
the growth of domestic incomes.
Graph 9
Bulk Commodity Spot Prices
US$ per tonne
Iron ore*
US$
US$
150
150
100
100
50
50
US$
US$
Coking coal
300
300
150
150
US$
US$
Thermal coal
180
180
120
120
60
60
0
l
l
2004
l
l
2006
l
l
2008
l
2010
0
* Calculated using the spot import price in China less the spot freight rate from
Australia to China
Sources: Bloomberg; Citigroup; Macquarie; RBA
In contrast to the terms of trade, one area that does get high-frequency attention is the
property market. Over recent times, most indicators of conditions in the established
housing market have been very buoyant. Auction clearance rates have been high and
nationwide measures of housing prices have been increasing by around 1 per cent a
month, with prices in Melbourne rising at an even faster pace (Graph 10). The rental
market also remains quite tight, with rents having risen firmly and vacancy rates low.
9.
Graph 10
Capital City Housing Prices
2005 = 100
Index
Index
130
130
RP Data-Rismark
120
120
APM
110
110
100
100
90
90
2005
2007
2006
2008
2009
2010
Sources: APM; RBA; RP Data-Rismark
There are, however, a few contrary signs to this generally strong picture. Total
housing loan approvals declined in October, November, December and January, with
the declines broader than just for first-home buyers following the scaling back of the
additional grants (Graph 11). Some lenders have also tightened terms and conditions,
including by further reducing maximum loan-to-valuation ratios (LVRs). And in the
lower-priced suburbs of the capital cities, housing prices have broadly moved
sideways since October, after earlier significant rises.
Graph 11
Housing Loan Approvals*
$b
$b
Non-FHB owner-occupiers
8
8
6
6
4
4
Investors
2
2
First home buyers
0
0
2002
2004
2006
2008
2010
* Excludes owner-occupier refinancing, alterations and additions and
investor approvals for new construction and by ‘others’
Sources: ABS; RBA
Looking forward, it is too early to tell whether these contrary signs indicate that some
cooling in the property market is in prospect. It is, however, clearly desirable to avoid
significant imbalances developing in the housing market, both in terms of the supplydemand situation and the price and financing dynamics. The pick-up in dwelling
construction that is occurring will be helpful here, although further increases are
likely to be needed over the medium term. On the financing side, we are currently not
10.
seeing the type of financial developments that caused concern in 2002 and 2003 when
maximum LVRs were being raised, loan servicing requirements were being eased,
new types of mortgage products were being introduced, and risk spreads were being
compressed. This is good news, as it would obviously be unhelpful if a speculative
cycle were to emerge on the back of the recent strength in housing prices. This is an
area that lenders and current and prospective home owners will need to watch
carefully over the months ahead.
The final topic that I would like to touch on briefly is inflation.
Here things have proceeded pretty much as expected. In underlying terms, inflation
has moderated significantly, and the year-ended rate is expected to decline from its
current rate of around 3¼ per cent to around 2½ per cent over the course of 2010.
This decline is being underpinned by the sharp slowing in wage growth in the private
sector that we saw over the past year and the appreciation of the exchange rate. In
addition, the Reserve Bank’s liaison with retailers suggests that there has been
significant discounting recently, and business surveys point to below average price
increases.
As we move forward, we need to ensure that inflation pressures remain contained and
that inflation expectations remain well anchored. Expansion of the supply side of the
economy is obviously important here. So too is addressing potential bottlenecks and
ensuring that our labour and capital markets are sufficiently flexible so that resources
are able to move to where they are most productive. In addition, as the Bank has
noted a number of times, with the economy having relatively limited spare capacity,
it is likely that interest rates will need to continue their gradual move towards more
normal levels.
Conclusion
In summary then, our central scenario is for the world economy to grow at around an
average pace over the next couple of years, with strong growth in a number of our
major trading partners in Asia. However, around this central scenario there are
significant risks as the flow-on effects of the events of the past 18 months continue to
reverberate around the global economy. While we need to watch these flow-on effects
carefully, the outlook for Australia appears to be considerably brighter than that for
most other advanced economies.
Thank you.